Question: You arrived at work today to see the CFO, COO and most of the company's top management team taken away in handcuffs. The only executive who was not arrested was the newly appointed CEO. Before you can even reach your cube, the CEO calls you into his office to explain some incomplete project analysis left on the CFO's desk. Below are the two mutually exclusive projects under consideration.
|
Year
|
Project A
|
Project B
|
|
0
|
(171,000.00)
|
(198,000.00)
|
|
1
|
46,000.00
|
55,000.00
|
|
2
|
79,000.00
|
34,000.00
|
|
3
|
51,000.00
|
120,000.00
|
|
4
|
65,000.00
|
25,000.00
|
|
5
|
23,000.00
|
75,000.00
|
|
IRR
|
17.82%
|
16.22%
|
While a marketing genius, the CEO has very little experience in finance, and would like to simply choose 'Project A' because "it earns a higher return for the company."
a. Explain (in words and graphically) why the CEO's reasoning could be flawed.
b. If your firm has a cost of capital of 8%, how much value will the firm lose out on by choosing the project with the highest IRR?